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Preferred Lender Lists
Many colleges publish lists of recommended lenders, called
preferred lender lists. Usually there are several lists, with
each list focusing on a different category of loans. The preferred
lender lists can include lists for undergraduate Stafford loans,
parent PLUS loans, graduate Stafford loans, graduate PLUS loans,
consolidation loans, and private student loans. Most preferred lender
lists include 4 to 10 lenders.
No Uniform Critera
Each college sets its own criteria for which lenders will appear on
its preferred lender list. Although the process is in most cases
objective and unbiased, it is not necessarily focused solely on
cost. Many colleges consider other factors, such as the quality of
customer service, the speed of problem resolution, and counseling
activities. For example, most students want 24/7 customer service via
toll free phone numbers and online interfaces, but don't realize this
until later. Likewise, when alumni encounter problems with a lender,
they usually turn to the financial aid office at their alma mater for help.
The college may also consider the availability of tools from the
lender to ease their administrative burden, such as an online
interface to streamline the certification, processing, disbursement
and management of loans borrowed by the school's students. Some
colleges may receive payments or other benefits from the lenders, and
should disclose this prominently with any publication of the preferred
lender list.
To see some of the criteria colleges use to evaluate lenders, see the
Guide to Developing a Preferred Lender List
published by the National Association of Student Financial Aid
Administrators in May 2005.
New York Attorney General
In 2007, New York Attorney General Andrew M. Cuomo said that the
cooperative relationship between some lenders and colleges was a bit
too cozy, with the lenders paying referral fees or providing other
benefits to colleges in the fierce competition to get on a college's
preferred lender list. While the colleges argued that they used the
money to provide need-based financial aid to students who otherwise
would be ineligible for assistance, several colleges and lenders
enterred into settlements with the attorney general, partly in order
to avoid the prospect of expensive litigation.
The settlements included an agreement by the colleges and lenders to
comply with a
College Code of Conduct.
This code of conduct establishes a standard concerning acceptable and
unacceptable behavior. This will likely lead to an improvement in the
objectivity of college preferred lender lists.
FinAid has a separate section that discusses the laws and regulations
concerning
prohibited inducements and preferred lender lists.
Borrowers May Pick Any Lender
Federal law requires colleges to certify federal education loans
without regard to the borrower's choice of lender or the guarantee
agency used by the lender. So you can choose any lender, including
those that are not on the college's list of recommended lenders.
Colleges are prohibited from introducing artificial delays into the
loan certification process.
If a college or lender provides you with a loan application that has
the lender name and code already filled in, you are not required to
use that lender. You can substitute the lender of your choice (or
better yet, get a blank loan application by calling the lender you
wish to use).
Shop Around
So while a college's preferred lender list is a good starting point,
prospective borrowers should also look at other lenders, such as
lenders that advertise in print, on air, online and by mail. Which
lender you choose does make a difference, as lenders offer loan
discounts that can save you hundreds or thousands of dollars of
interest over the lifetime of the loans.
FinAid has
comprehensive lists of education lenders, including
lists of
education lenders,
student loan discounts
and private student loans,
sorted alphabetically,
and a list of the
largest FFEL lenders, sorted by loan
volume. FinAid also maintains a
Lender Code Database
of lenders that participate in the Federal Family Education Loan
Program (FFELP). There are also other sites that offer much smaller lists
of lenders, such as
eStudentLoan
and
SimpleTuition. It is
important to recognize that all of these sites have ties to lenders,
who may advertise on the sites or pay referral fees.
State guarantee agencies and non-profit lenders sometimes have some of
the lowest interest rates on federal and private student loans. These
rates may be restricted to students who are state residents or attend
a college in the state. Be sure to compare these rates with the rates
available from banks and other for-profit lenders.
So do a little research on the lenders, instead of blindly picking the
first lender on the preferred lender list. Visit the lender web sites
for the latest information on their discounts and services, and put
together a chart comparing and contrasting the lenders according to
the features that are important to you.
Tips on Choosing a Lender
FinAid has a separate section that focuses on tips for
choosing a lender.
There is also some discussion of the
tradeoffs between federal and private student loans.
Here are a few
additional tips:
- Federal loans are cheaper than private loans. They have
lower interest rates and fees.
The federal loans also have fixed interest rates and more favorable
repayment terms.
Exhaust federal education loans, such as the Perkins, Stafford
and PLUS loans, before turning to private student loans. The Perkins
loan is the least expensive, followed by the subsidized Stafford loan and
unsubsidized Stafford loan, and then the PLUS loan. Private student
loans are more expensive than federal education loans, but less
expensive than credit cards. The unsubsidized Stafford loan and the
PLUS loan are not based on financial need.
- Lenders may offer discounts on the interest rates and fees on federal education loans.
Federal law sets the maximum interest rates and fees a lender may
charge on the Stafford, PLUS and Consolidation loans. Nothing prevents
a lender from charging lower rates and fees. Many lenders offer
discounts to attract borrowers.
- Focus on immediate discounts and discounts you can't lose.
Lenders offer many different discounting schemes, and it can be
difficult to evaluate which discounts are better.
(FinAid provides a
Loan Discount Analyzer
which can help you identify which loan discounts are best for your situation.)
It is best to focus
on discounts which you can't lose, such as 0.25% to 0.50% interest
rate reductions for having the monthly payments automatically debited
from your bank account, unconditional interest rate and principal reductions,
and on discounts that are immediate, such as
loan fee waivers and rebates. But beware of fine print that requires
you to repay a fee rebate if you consolidate the loan with another
lender. Very few borrowers qualify for the full
amount of prompt payment discounts, as it is difficult to make all
your payments on time. Delayed onset of the discounts also
significantly reduces their value, since they are in effect for a
shorter period of time. If the lender offers such prompt payment
discounts, focus on those that have as short a delay as possible and
which do not require ongoing behavior after you reach the milestone
(e.g., prefer principal reductions to interest rate reductions).
Also be sure to tell the lender when you move to a new
address. Anecdotal evidence suggests that most borrowers who lose
prompt payment discounts do so on the very first payment.
- Pick as short a loan term as possible.
While a longer loan term will reduce the size of the monthly payment,
it will significantly increase the interest paid over the lifetime of
the loan. For example, increasing from a 10 year loan term to a 20 year
loan term may cut the monthly payment by a third (34% reduction), it
comes at a cost of more than doubling the interest paid over the
lifetime of the loan. The maximum reduction in the size of the monthly
loan payment is 50%, at a cost of more than tripling the interest paid
over the lifetime of the loan. Keep the loan term short to save
money. Also, do you really want to still be repaying your own student
loans when your children are ready to enroll in college?
You can change the repayment schedule on your loan once per year. So
FinAid recommends starting off with standard ten-year repayment on
your consolidation loan. If you find it difficult to afford the
payments, you can always switch to extended repayment later.
- Discounts on unconsolidated Stafford and PLUS loans are
often better than the discounts on consolidation loans. Lender
margins are 0.75% tighter on consolidation loans than on
unconsolidated loans, leaving them with less room to provide
discounts. This is one of the reasons why consolidation lenders
encourage extended repayment, since it compensates for the lower
margins. So it is best to compare your current loan discounts with the
discounts on a consolidation loan before deciding whether to
consolidate. A consolidation loan is a new loan, with a different set
of discounts than the original loans. Also, some fee waivers or rebates offered by originating
lenders may have to be repaid if you consolidate with another lender,
so be sure to ask your current lender about that as well.
- You don't need to consolidate to get extended repayment.
A little known provision of the Higher Education Act of 1965, in
section 428(b)(9)(A)(iv), allows borrowers to get extended or graduated
repayment without consolidating their loans. The borrower must have
accumulated more than $30,000 in federal education debt since 1998.
The extended or graduated repayment plan may have a loan term of up to
25 years.
Per the regulations at 34 CFR 682.209(a)(6)(ix), the borrower must not
have had any outstanding federal education debt prior to October 7,
1998 at the time of obtaining a new education loan subsequent to that date.
Many lenders also offer unified billing, so that you get one bill
for all your loans from that lender.
- Apply for private student loans with a cosigner.
Private student loans based the interest rates and fees on your credit
score. So even if you can qualify for a private student loan on your
own, it is better to apply with a cosigner, as this can result in a
lower interest rate and fees, saving you money. This is especially
true if the cosigner has a better credit score.
- Private student loans pegged to LIBOR are better than those pegged to the Prime Lending Rate.
Prime + 0% may sound better than LIBOR + 2.8%, but they are in the
same ballpark. The Prime Lending Rate is the interest rate lenders
give to their best credit customers. The LIBOR rate is the interest
rate at which lenders can borrow money from other banks. Since the
spread between Prime and LIBOR has been growing, a variable rate loan
pegged to the LIBOR index will grow more slowly than a loan pegged to
the Prime Lending Rate.
- Some private loan interest rates and fees depend on the school you attend.
While most private loans consider your credit history, some may also
consider other factors such as the college you attend. In particular,
these lenders will consider your college's
cohort default rate
in addition to your FICO score when determining the interest rates and
fees that you pay. From the lender's perspective, higher default rates
yield loans that are less profitable, and some lenders compensate for
that by charging higher rates and fees. (It is unclear why borrowers at
high default rate schools are more likely to default than borrowers
with the same credit score at low default rate schools. It may be an
indication of the likelihood that students at the school will graduate
and get a good job.) If your school has a default rate that is more
than twice the national average (i.e., more than 10%), you may wish to
focus on lenders that don't consider the college's default rate, as
these lenders are more likely to offer better interest rates. Shop
around to get the best interest rate and fees, as there is
considerable variation from lender to lender.
- Don't apply for too many private student loans. Many
students find that their credit scores go down with each year's loans,
causing their interest rates to increase. While loan applications
don't have as big an impact on your credit score as funded loans,
applying for too many loans may be enough to tip you from one credit
tier into the next, especially if your credit score was close to the
threshold between credit tiers. (Lenders don't publish their credit
tiers, but typically have 5 or 6 tiers for credit scores between 650
and 850. This means that a change of just 30-50 points in your credit
score is all that is required to change from one tier to the next.)
Given that private student loans do not have up-front pricing, the
only way to tell what interest rate you'll get is to apply. But if you
apply for more than 2 or 3 private student loans, it may
impact your credit score. This is a bit of a catch-22 situation. But
here are a few rules of thumb that can help, based on an analysis of
private student loan securitizations:
- Look at the lender's best and worst rates, and use them to
calculate the spread between the two. If a lender has a very low rate
for the most creditworthy customers, but a large spread between best
and worst rates, most borrowers will end up with a higher interest
rate than at a middle-of-the-road lender with a much tighter spread
between best and worst rates.
- Between 40% and 60% of the typical lender's funded loans get the
worst rate, and more than three-quarters of the approved loan
applications. So put more emphasis on the worst rate when comparing
private student loans, since the odds are good that that's the rate
you'll get.
- Less than 10% of the typical lender's funded loans get the best
rate.
- On average, borrowers receive interest rates that are 2.5%
to 3.0% higher than the best advertised rate.
So to have a good chance of getting a good rate, one of your loan
applications should be at a lender with one of the best rates for the
most creditworthy customers, another at a lender with a narrow spread
between the best and worst rates and the third at a lender with one of
the lowest worst rates.
According to
Fair Isaacs,
the company that produces the FICO score used by most education
lenders, one "inquiry" will generally result in a 5 point reduction in
the FICO score. However, since people with six or more inquiries are
eight times more likely to declare bankruptcy than people with no
inquiries, it is best to keep the number of inquiries small. Also,
if your credit history is short or involves very few accounts, an
inquiry is likely to have a bigger impact. On the other hand, when you
apply for a loan, they ignore any inquiries within the 30 day period
prior to scoring and treat any inquiries within a short period of time
(e.g., 14 or 45 days, depending on the version of the FICO score) as a
single inquiry. This compensates for the impact of shopping
around. They do not say whether applying for different types of loans
(e.g., credit card, mortgage, student loan) counts as separate
inquiries, but that is likely the case. So
the best advice is to apply for all the private student loans within a
short time period (e.g., a week or two) and to not apply for too many
loans.
[Warning: Fair Isaacs says that while they conflate
inquiries for auto loans and mortgages, they do not yet have enough
historical credit data to do this for private student loans. This is
partly because private student loans are relatively new and partly
because lenders have not been distinguishing private student loans
from other forms of unsecured credit. So you still need to limit the
total number of private student loan applications and to apply for the
loans in a short time span. More than five
inquiries is likely to reduce your credit score enough to have an
impact on the interest rates and fees for subsequent
applications. More than eight inquiries will definitely have an impact
on the interest rates and fees.
FinAid recommends limiting your private loan applications to one bank,
one non-bank specialty lender and the nonprofit state loan agencies in
your home state and the state where your college is located.]
- Minimize fees if you intend to prepay the debt.
Education loan fees, like points on a mortgage, are effectively
a form of up-front interest. If you intend to pay off the
loan early (i.e., just a few years into repayment) you should prefer a loan
with lower fees, as this will save you money.
For example, consider a student loan with a ten year repayment term,
where the loan fees are added to the amount owed to yield net proceeds
of $10,000. At 7.5% interest and 7% fees you'd have total payments of
$15,316.15 over the lifetime of the loan. At 8.5% interest and 3% fees
you'd have total payments of $15,338.46 over the lifetime of the
loan. So the loans have similar costs. But if you were to pay off the
remaining balance after just three years, your total payments on the
7.5% loan would be $12,916.32 and your total payments on the 8.5% loan
would be $12,672.79, or $243.53 less.
The longer the repayment term and the longer you wait to pay off the
loan, the more time there is for the loan fees to be amortized over
the term of the loan. So the impact of loan fees on total costs
decreases the longer you wait to pay off the loan. Given two loans
with similar APRs, you should prefer the loan with the lower fees if
you intend to pay off the loan within the first few years of entering
repayment.
- It is cheaper to save than to borrow.
If you save $200 a month for ten years at 6.8% interest, you will
accumulate more than $34,400 to help pay for college. If instead of
saving, you borrow this amount at 6.8% interest, you will pay almost
$400 a month for ten years. So start saving for college as soon as
possible. FinAid's
Saving vs. Borrowing Calculator
lets you explore the tradeoffs of saving versus borrowing to pay for college.
- Borrow no more than your expected starting salary.
If your total college debt is about the same as your starting salary
after you graduate, the monthly loan payments will be
affordable. If you borrow more than your starting salary, you may find
it difficult to repay your debt. While one can choose alternate
repayment terms that reduce the monthly payment by stretching out the
term of the loan, these increase the total amount of
interest you will pay over the lifetime of the loan. For example,
increasing the loan term from 10 years to 20 years may cut the size of
the monthly payment by about a third, but it will more than double the
amount of interest you pay over the life of the loan. If you borrow
more than twice your expected starting salary, you will be forced to
seek extended repayment terms and will be at high risk of defaulting
on your debt. You should consider transferring to a less expensive
school.
- Minimize debt. Live like a student while you are in
school, so you don't have to live like a student after you graduate.
Fixed vs Variable Interest Rates
There are several tradeoffs between fixed and variable interest rates.
- Fixed rates offer predictable monthly payments. With variable rate
loans, the monthly payment can jump after a rate reset, making the
monthly payment less affordable. This is especially true after the end
of a low introductory or "teaser" rate. For example, a 1% increase in
the interest rate typically leads to a 4% to 9% increase in the
monthly payment.
- Variable rate loans may offer low introductory rates that don't
last for long, either for the duration of the in-school period (an
average of about 2 years) or just a year.
- Variable rates can cut costs when interest rates are
declining, letting variable rate loans seem low compared with fixed
rate loans. However, variable rates can increase costs when interest
rates are increasing. One must be concerned about the average rate
over the life of the loan, not interest rates that are temporarily low
or high compared with fixed rates.
In Case of Difficulty
If you are encountering problems getting a college to certify your
loan because of your choice of lender, contact the
FSA Ombudsman
at the US Department of Education. You can contact the ombudsman
online,
by email at fsaombudsmanoffice@ed.gov,
by phone at 1-877-557-2575, by fax at
1-202-275-0549, or by mail at U.S. Department of Education, FSA
Ombudsman, 830 First Street, NE, Fourth Floor, Washington, DC
20202-5144.
You can also report suspected fraud to the Office of the Inspector
General at the US Department of Education by calling 1-800-MIS-USED.
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